Tuesday, May 27, 2014

Private Equity Returns to Australia and Europe?

When it comes to investing in Australia, private-equity firms are back.

After a lull in activity Down Under in the wake of the 2008 financial crisis, global firms such as KKR & Co. and TPG Group are on the hunt again, having recently raised large amounts of capital to deploy in the Asia-Pacific region. That has inspired a renaissance of buyout activity in Australia, one of the few markets in the region where private-equity firms can do full takeovers.

In the first five months of the year, announced private-equity takeover deals in the country hit US$5.5 billion, according to Dealogic, higher than the amount for any full year since 2006.

“Many of the large local and global private-equity firms have recently raised new funds, so they have significant war chests,” said John Knox, Credit Suisse’s co-head of investment banking in Australia.

He added that “debt markets are very strong, probably the strongest they have been since 2007,” allowing private-equity firms to take on more leverage at a lower cost.

Asian and Australian banks have been eager to lend to deals in recent months, while the U.S. debt markets have become a source of funding for Australian deals, giving firms a number of options when it comes to securing debt.

Meanwhile, fundraising in Asia has picked up steam in recent months, with KKR last year raising a US$6 billion Asia fund, the biggest-ever for the region and TPG closing a US$3.3 billion fund last week. Australian private-equity firm Pacific Equity Partners, or PEP, meanwhile, is currently raising capital for its fifth fund, potentially targeting around three billion Australian dollars (US$2.8 billion), a person familiar with the raising said. It will be competing for capital with Carlyle Group, which is also looking to raise a US$3.5 billion fund for Asia.

That has led to a spurt of jumbo deals in Australia. Compliance services provider SAI Global Ltd. said Monday that PEP bid A$1.1 billion (US$1 billion) for it. Last week, KKR bid A$3.05 billion for Treasury Wine Estates Ltd., the world’s second-biggest listed vintner. Also, TPG bid for the DTZ property services unit of Australian engineering company UGL Ltd., a person familiar with the matter said earlier this month, in a deal that could be valued at more than A$1 billion. Treasury Wine rejected KKR’s offer but said it is open to others, while UGL said it is still assessing the merits of any offers for DTZ.

“Many companies have been waiting for an opportunity to restructure their operations by unloading units that are deemed to be noncore to some of their strategic objectives, and private-equity funds tend to pick up those types of businesses,” said Yasser El-Ansary, chief executive of the Australian Private Equity & Venture Capital Association.

UGL considers DTZ to be a noncore asset, while other companies across myriad sectors have indicated, too, that they could part with business units to help bolster their balance sheets.

National airline Qantas Airways Ltd., for example, is considering a sale of its frequent-flier business, while mining company BHP Billiton Ltd. is shopping assets considered marginal to its operations. Australia’s slowing mining boom has also thrown up potential companies private-equity firms can set their sights on.

“The economic environment in Australia has been relatively tough, and many believe the outlook is better,” Mr. Knox said. “Some companies haven’t been able to grow so they are natural targets.”

Meanwhile, Australia’s stock market is up 11% in the past 12 months, after the central bank relaxed interest rates to help spur growth. The Reserve Bank of Australia has cut interest rates eight times over the past two years to a record-low 2.5%, helping to drive activity in the country’s housing market and potentially reigniting the retail sector.

With the stock market hovering near six-year highs, private-equity firms can now exit from investments through initial public offerings. That option hasn’t been readily available over the past few years. TPG’s disappointing float of department store Myer in late 2009 left investors wary of new offerings.

The IPO market, however, is starting to show signs of life again. PEP partially exited from cleaning-and-catering company Spotless Group Ltd. through an IPO last week and TPG and Carlyle are considering a float of hospital operator Healthscope in a deal that could raise around A$5 billion for its private-equity owners.

New floats help free up capital for private-equity firms to invest. Moelis & Co. analyst Adam Michell said SAI Global, for example, might receive rival offers from other private-equity firms in need of investment opportunities after recent IPOs.

These dynamics should keep private-equity buyouts of Australian companies robust in the next year.

“It’s very likely that in the coming 12 months or so we’ll continue to see a heightened level of deal activity,” Mr. El-Ansary said. “There are a range of industry sectors that have a strong outlook over the coming years—look, for example, at the level of deal activity in the health-care and aged-care space.”

Private equity firms and trade players in the US are increasingly looking to buy European mid-market businesses as they face a saturated deal market at home and seek value elsewhere.

Alan Giddins, co-head of private equity at 3i Group, said: “We have undoubtedly seen an increased number of US private equity houses, who don’t have offices in Europe, competing in European auction processes.”

Rod Richards, managing partner of mid-market firm Graphite Capital, noted that five of the nine businesses the firm has sold in the past three years have been to US bidders.

Three of them went to financial buyers, with interest from unexpected sources such as New Mountain Capital and AEA Investors, which bought recruitment outsourcing company Alexander Mann in October and NES Global Talent in 2012 respectively.

Advisers often cite the acquisition of UK consumer data company Callcredit by GTCR, a Chicago-based private equity fund, as evidence of the trend. The US firm does not have a European office.

Thierry Monjauze, who heads the European operations at US mid-market investment bank Harris Williams & Co, said: “There is no doubt that there has been a significant increase in activity level from US private equity firms into Europe. Many US firms are spending more time in Europe pursuing acquisitions and indeed a few have opened up offices internationally.”

Richards at Graphite Capital said that some US buyers were seeing UK companies as a platform for expansion into Europe, partly because the US market had become more competitive and Europe was seen to have more opportunities for value, while others were providing a route for the acquired company to expand into the US.

US private equity firms also tend to make their investment decisions quickly, agreeing a price early and completing the deal, according to Richards.

So far this year there have been 13 acquisitions of European targets by US private equity firms, worth $8.7 billion, according to data provider Dealogic.This is already 37% higher than the total of such deals done in the whole of 2013, but down on the $30.9 billion-worth completed in 2012.

Monjauze said: “A few years ago, it was not commonplace to consistently see US PE firms show strong interest in European sale processes, whereas now sellers expect significant US interest. This phenomenon has created a dynamic where local PE firms are having to compete and pay more for assets.”

US advisers are also gearing up in Europe. US-based financial services firm Stephens, which has private equity, investment banking and wealth management arms, is looking to establish a presence in London, Financial News reported last week.

I bring these articles to your attention for several reasons. First, cheap debt is the primary factor fuelling private equity activity everywhere, not just Australia.Second, while there are opportunities to restructure companies, I'm worried about the leverage PE funds are using to enter these deals and their exit strategy. The IPO market is showing signs of life but for how long?

Third, and more importantly, I worry about local and global funds with "significant war chests" bidding on deals, raising the valuations to ridiculous levels. This morning I had an email exchange with Mark Wiseman, congratulating him on CPPIB's fiscal 2014 results, but told him I'm worried about public and private markets going forward and I don't envy him. He told me flat out: "indeed...tough times to invest in."

Put yourself in Mark Wiseman and André Bourbonnais' shoes. You have billions to allocate in private equity and you worry about cheap debt and bidding wars raising prices on deals. You try to navigate as responsibly and as prudently as possible but in this environment, you're going to get caught up in the private market frenzy. I just hope rates stay low for a very long time because if they unexpectedly start rising, it will get very, very ugly out there.

Of course, I'm more worried about deflation, especially in the eurozone, so I don't see any reason to worry about a significant rise in interest rates anytime soon. In fact, I predict the ECB will finally start engaging in massive quantitative easing which will spur gold shares and gold prices, at least in the short run. I would stay short the euro, the CAD and Aussie dollar in this environment.

Finally, according to Economic Times, Ontario Teachers is part of TPG's $1 billion consortium bid on real estate services company DTZ, teaming up with PAG, helmed by its former senior executive Weijian Shan.

Below, Laurence Tosi, chief financial officer at Blackstone Group LP, talks about his role as CFO, the private-equity industry, and Blackstone's performance. He speaks with Jason Kelly at the Bloomberg Link CFO Conference in New York.

And Adena Friedman, chief financial officer of Carlyle Group LP, talks about the evolving role of the CFO, the private-equity industry and public investors' understanding of the firms. She speaks with Jason Kelly at the Bloomberg Link CFO Conference in New York.

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I am an independent senior economist and pension and investment analyst with years of experience working on the buy and sell-side. I have researched and invested in traditional and alternative asset classes at two of the largest public pension funds in Canada, the Caisse de dépôt et placement du Québec (Caisse) and the Public Sector Pension Investment Board (PSP Investments). I've also consulted the Treasury Board Secretariat of Canada on the governance of the Federal Public Service Pension Plan (2007) and been invited to speak at the Standing Committee on Finance (2009) and the Senate Standing Committee on Banking, Commerce and Trade (2010) to discuss Canada's pension system. You can follow my blog posts on your Bloomberg terminal and track me on Twitter (@PensionPulse) where I post many links to pension and investment articles as well as my market thoughts and other articles of interest.

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